Alternative Investment Industry Outlook for Remainder of Q4 and Early 2017
The conclusion of 2016 is nearly upon us, highlighted by large institutions redeeming from equity-focused hedge funds and funds of hedge funds in favor of private equity while family offices have been more amenable to them. The industry has also seen more launches in the credit/debt, private equity and real estate space and a slowdown in new long/short equity debuts. Further, hedge fund managers have been instating more creative fee terms to accommodate allocators. With respect to these abovementioned topics, EisnerAmper anticipates what’s in store for the remainder of this year and early next year for the alternative investment industry.
We’re seeing that a number of institutional investors including insurance companies, pensions, endowments and foundations are continuing to pare down their hedge fund portfolios in favor of private equity. At EisnerAmper’s September Breakfast Series event, investment representatives from large institutions, including MetLife Investments and Morgan State University Endowment in Baltimore, said they have reduced their hedge fund portfolios in favor of private equity and other less liquid investment opportunities.
Maria Tarhanidis, Managing Director, Alternative Investments-Hedge Funds at MetLife Investments, said the pension will continue to favor both mezzanine debt and private equity because they have performed better than hedge funds, which they have eliminated.
“While we think the returns going forward will be lower than they have been for mezzanine debt and private equity, since they have been great for many years, we think they can still be attractive and more so than hedge funds,” she said.
Additionally, EisnerAmper has heard that family offices continue to be more open to hedge funds. Engineers Gate Investments in Connecticut continues to favor both emerging managers and credit offerings.
“We are thinking of increasing our credit exposure due to the interest rate environment,” said Robert Maroney, Founder of Engineers Gate. “Some of the niche credit funds we have invested in have done well, especially those focused on secured loans.”
Additionally, capital introductions personnel from organizations ranging from the biggest prime brokerage firms to second tier ones and boutique firms told EisnerAmper that family offices continue to favor low-net long/short equity managers, both generalist and sector focused, especially in health care, TMT, consumer and energy, along with market-neutral, quant and systematic hedge fund strategies. And on the less liquid side, they are looking at direct lending and private equity opportunities.
With respect to launch activity, EisnerAmper has witnessed a significant uptick in credit/debt, private equity and real estate while there has been a slowdown in long/short equity debuts, along with new venture capital offerings.
“The current interest rate trends and fixed-income yields are perceived as offering an opportunity to managers in credit strategies that has generated a lot of interest among managers investing in fixed-income instruments of all types,” said Keith Miller, Partner in the Financial Services Group in EisnerAmper’s San Francisco office.
He added that real estate continues to be attractive on the West Coast and fund strategies holding or connected to real estate continue to launch as a result.
Investors, especially seed investors, continue to have the upper hand when it comes to fee negotiation with managers, and managers will continue to find ways to accommodate them.
"Fund managers have continued to get more creative with their terms and fee structures,” said Jaclyn Greco, Manager in the Financial Services Group in EisnerAmper’s New York office. “We’ve seen new managers incorporate longer lock-up periods as well as preferred returns or ‘hurdles’ before the incentive fee is earned, to further align their interests with investors. Some managers are even using tiered fee structures, where in Year 1 they are charging X management and incentive fees, Year 2 they are charging Y and Year 3 they are charging Z. This is a further enticement for an investor to keep their capital in the fund for longer periods."
Miller added, “What I am seeing is far more managers looking at reducing their carry from 20% to 15%. Some founders’ classes are offering a 10% carry in return for a lock-up. I feel like I’m seeing real fee pressure there. Founders’ classes aren’t particularly new. They’ve been around for a few years but they do seem to be a fairly standard feature of most new launches now.”
For the remainder of 2016 and early 2017, it is evident that the majority of hedge funds will continue to face challenges raising capital from the biggest institutional investors as they are paring back their hedge fund allocations in favor of private equity and less liquid alternative investment opportunities. Further, the interest rate environment is expected to be promising for new credit fund launches at least in the near term. Finally, managers are expected to be more flexible with regards to their fee structure to entice investors.
Elana Margulies Snyderman is a senior manager in EisnerAmper’s Financial Services Group.
Asset Management Intelligence - Q4 2016